Fitch Ratings has downgraded Romania’s Long-Term Local Currency (LTLC) IDR to ‘BBB-‘ from ‘BBB’ and affirmed the Long-term Foreign Currency (LTFC) IDR at ‘BBB-‘. However, the Outlooks are stable, the rating agency announced in a press release.
The issue ratings on Romania’s senior unsecured foreign currency bonds have been affirmed at ‘BBB-‘. Romania’s senior local currency bonds have been downgraded to ‘BBB-‘ from ‘BBB’. The country ceiling has been affirmed at ‘BBB+’ and Short-term Foreign Currency (STFC) IDR at ‘F3’. Fitch has assigned a new Short-term Local Currency (STLC) IDR rating of ‘F3’.
“The downgrade of Romania’s LTLC IDR to ‘BBB-‘from ‘BBB’ reflects the following key rating drivers: In line with the updated guidance contained in Fitch’s revised Sovereign Rating Criteria dated 18 July 2016, and as part of a broader portfolio review, Fitch concluded that Romania’s credit profile no longer supports a notching up of the LTLC IDR above the LTFC IDR. This reflects Fitch’s view that neither of the two key factors cited in the criteria that support upward notching of the LTLC IDR are present for Romania,” the quoted document reads.
Those two key factors are a strong public finance fundamentals relative to external finance fundamentals and previous preferential treatment of LC creditors relative to FC creditors.
The assignment of a STLC IDR of ‘F3’ to Romania is consistent with Fitch’s approach to assigning ST ratings by using its LT/ST Rating Correspondence table to map the STLC IDR from the LTLC rating scale.
Romania’s ‘BBB-‘ LTFC IDR balances a favourable economic growth outlook, against fiscal risks from increased pro-cyclical fiscal policy and upcoming elections in November this year. In addition, a larger net external debtor position than the ‘BBB’ median and structural weaknesses in the economy remain constraints on the rating. Fitch’s 2016 and 2017 fiscal deficit forecasts, at 3 percent and 2.9 percent of GDP, respectively, remain unchanged from six months ago.
However, Fitch continues to highlight the negative pressures on medium-term fiscal sustainability as a result of sizeable tax cuts under the Fiscal Code. In the rating agency’s view, the vulnerability of public finances is also heightened in light of the current electoral cycle, which in H1 of 2016 saw the approval of several populist measures, including a new public wage bill due to come into effect August 2016 increasing government spending, as well as a legislative initiative promoted by parliament for further social security contribution cuts.
Romania’s widening fiscal deficit also puts upward pressure on general government debt, which in recent years has gradually deteriorated towards the median debt ratio of the ‘BBB’ range.
Fitch’s latest medium to long-term baseline projects government debt to reach 39.6 percent of GDP in 2016 from 38.4 percent in 2015, remaining on an upward trend, but staying below 45 percent over 10 years, a level which is not necessarily incompatible with an investment grade rating. Refinancing and interest rate risks are low, with around 85 percent of total debt stock in medium to long-term maturities, with fixed rates.
“With robust growth in domestic demand, net exports will provide a negative contribution to GDP as import demand outpaces export growth,” Fitch analysts note.
Fitch’s latest projection is for an average real GDP growth rate of 4 percent for 2016-2017, above Romania’s 3.0 percent -3.5 percent economic growth potential and above the median of ‘BBB’ peers.
Romanian banks are well capitalised
Fitch rating point out that the domestic banks are well capitalised (sector capital adequacy ratio 19.5 percent, Q1 of 2016) and profitable (RoE 12.8 percent in 2015).The banks are sufficiently funded by local deposits and their balance sheets are gradually improving as the share of non-performing loans continues to decline.
However, the Debt Discharge Law approved in May, which allows individuals with a mortgaged-backed loan the ability to return real estate collateral to the banks in exchange for writing off their loan, has created an uncertain outlook for the sector.
Romania’s rating remains constrained by its higher net external debtor position than ‘BBB’ peers, estimated by Fitch at 20.3 percent of GDP for 2016, compared with the ‘BBB’ median estimate of 6.0 percent. The majority of external debt is attributed to the private sector. However, its sustainability is supported by ongoing trends of deleveraging and a relatively large share of intercompany lending. Since peaking at 39.2 percent of GDP back in 2012, Fitch forecasts net external debt to continue gradually declining in 2016-2017.
“Fitch assumes that under severe financial stress, support for Romanian subsidiary banks would come first and foremost from their foreign parent banks. Fitch assumes Romania’s main economic partners in the EU will benefit from a gradual economic recovery,” the release concluded.